Model Insights: Replicating Portfolios for Economic Capital?
Document ID: 2008-1136
Published on: 28th October 2008
Author: Steven Morrison
In this note we demonstrate the use of RPs for calculation of economic capital requirements using a simple illustrative example. This analysis indicates that an apparently good RP (based on a standard goodness-of-fit metric) can result in significant errors in estimated capital requirements. We also indicate how the RP technique can be supplemented with Monte Carlo valuation techniques in order to minimise the approximation errors introduced by the use of RPs alone.
